Wednesday, June 03, 2009

When Bill Ackman of Pershing Square Capital Management attended Target's (TGT Quote) annual meeting in suburban Milwaukee last Thursday it was the final culmination of a months-long proxy fight with the company's incumbent board. Although some observers, including me, predicted Ackman's slate would win one or two seats out of the five he was seeking, he came away empty-handed. Target announced at the meeting that all incumbent directors were re-elected with at least 70% of the vote.

The mainstream press immediately declared it a rout against Ackman. "Target Triumphs Over Ackman" said BusinessWeek, "Ackman Misses Target" said the New York Post. The New York Times headline read, "Target Shareholders Strongly Reject Dissident Slate."

But the truth is that the vote was far closer than how Target spun it.

The language from Target's press release includes words like "shareholders appear to have" elected the incumbent directors by a "comfortable" margin. Gregg Steinhafel, Target's chairman, president and CEO, goes on to thank shareholders for their "overwhelming" support of management. Towards the end of the press release, Target suggests it will get around to actually releasing "preliminary" voting results in three to four weeks. Final results will come later, but no timeline was provided. Technically, Target doesn't have to share the final results until the end of August -- 60 days after the end of the quarter in which the annual meeting took place.

I find it insulting to shareholders that companies can get away with not releasing voting results immediately after the meeting. A month ago, Bank of America(BAC Quote), a much larger company than Target, with more votes to be counted, and also facing a large number of dissenting shareholders, provided a detailed accounting of its tally before 5 p.m. the same day as the meeting. Target gets to drag its feet for three months, while posturing to the press working on deadline that it enjoyed a sizable win.

Doesn't this sound more like how a banana republic runs itself, rather than one of the largest retailers in the world?

Another aspect of the vote that inflated the results in Target's favor were the broker non-votes. We are now close to the end of the 2009 proxy season. Thanks to some recent changes by the Securities and Exchange Commission this will be the final year in which brokers can take all the non-votes they receive from their underlying shareholder clients and, in one fell swoop, throw the votes to management's favor. This happens in 99% of the cases in which they vote.

The Wall Street Journal recently concluded that, in most large company votes, these broker non-votes going in support of management amount to 15% to 20% of the overall votes counted. These votes should count as abstentions, since the real owners of the shares haven't indicated a preference. Starting in 2010, thanks to the SEC, that will happen.

Let's assume Target received the "overwhelming" support of 70% of their shareholders. Assuming a normal amount of broker non-votes landing on Target's side of the ledger, it appears that the vote, if it had taken place under next year's rules, would have been up for grabs.Scott Galloway, New York University Stern School professor and activist investor with Firebrand Partners, who also serves on the New York Times (NYT Quote) and Eddie Bauer (EBHI Quote) boards, sent a tweet out after the vote saying that it was "a blow to activists everywhere." For the reasons I've outlined, I'm more sanguine. However, I think it's important to understand where things went wrong in this campaign, as I certainly thought Ackman had adequately made his case sufficiently to win at least a couple of seats.

Here's how things went off the rails for Ackman.

1. Winning a proxy contest is like passing a major bill in Congress. It's not enough to be right, an activist has to put forward an argument that is politically palatable to other shareholders. Ackman ultimately failed in his proxy contest because he failed to win over the support of the biggest holders such as the large mutual fund companies and pension funds.

Although these investors pay close attention to corporate governance matters, their primary concern as fiduciaries is the long-term health and success of the company. Activists sometimes shoot themselves in the foot with these shareholders when they advocate solutions that are perceived to provide only a short-term boost to the stock instead of a more sustainable move. Ackman's real estate investment trust plan for Target, designed to unlock value in the land under Target stores, and creative from a financial engineering perspective, got no support. It was successfully painted by Target as "risky" and out of step with the current environment. Ackman never should have included it as part of his plan.

2. The messenger is a big part of the message. Any activist investor in a proxy contest should be able to convince fellow investors that they are advocating solutions which will benefit the company in the long term. Far too many activists formerly looked for short-term levers to pull to create value in their shares owned, such as paying out a large dividend, taking on debt, selling off a division to a private-equity firm, or doing a big stock buyback.

For the most part, these strategies have hurt the target companies. There are also many activists, and Carl Icahn is probably the most well-known example, who have cultivated an image of force and intimidation.

Hedge fund managers -- and activists especially -- are still seen by outsiders as short-termists. In the case of Ackman, he is who he is: a big New York hedge fund manager. He can't change that, but that image likely did bleed away potential supporters who, when they reviewed his REIT plan and heard about the number of Target derivatives he owned, prematurely dismissed his slate for not being a "long-term investor." In the final days before the vote, Ackman went out his way to issue press releases saying he was committed to holding his personal Target shares, not his fund's shares, for at least five years if he was elected to the board. By then, it was too late to change how he was viewed by his fellow shareholders.

3. Pick bulletproof fellow directors for your dissident slate. Ackman didn't help himself with the pick of Jim Donald as a fellow director on his slate. In TV interviews leading up to the vote, Donald didn't provide a compelling list of things he was going to attack once he got elected to the board. It fed into the view that Target wasn't really badly in need of improvement.

Ackman made a big deal of Donald's experience heading up Wal-Mart's (WMT Quote) grocery division, pointing out that Target should emulate Wal-Mart's performance there. Yet Donald also brought the baggage of his bio for being ousted from Starbucks(SBUX Quote) by the guy who hired him. It's not necessarily fair, but this baggage diluted the message Ackman was trying to get across.

4. The worse the stock performance track record of a company is the easier it is for an activist to make the case for change. Joe Nocera of the New York Times took Ackman to task for his Target activist campaign. Nocera questioned why Ackman would go after Target in the first place when the company's 10-year stock performance was actually better than Wal-Mart's. Not every poorly-performing stock makes an attractive activist target, but it's clear that poor performance is a necessary condition for any activist to win over broad support.

Under the SEC's 2010 proxy rules, just as many Target shareholders agreed with Ackman that Target's performance should have been better in recent years as other shareholders who would have sided with Nocera that all this was a waste of time. Yet, as Ackman made constant suggestions that Target should be more like Wal-Mart, it would have helped him more if there was clearly a stark difference between the stock performances of the two companies over some time. It wasn't compelling enough.

I am heartened by how many shareholders last week voted for an activist campaign that, although far from perfect, would have improved on the status quo at a sleepy board. Ackman made mistakes in this campaign that lost him the trust of the long-term holders of the stock. Even still, the final tally likely will show a very close contest.

And next year's new rules from the SEC will mean that investors like Ackman will no longer have to pay $15 million to run proxy contests. Target's vote is more likely to be an early warning of future activist successes than a death knell.

At the time of publication, Jackson owned no shares in the companies mentioned.Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

When Bill Ackman of Pershing Square Capital Management attended Target's (TGT Quote) annual meeting in suburban Milwaukee last Thursday it was the final culmination of a months-long proxy fight with the company's incumbent board. Although some observers, including me, predicted Ackman's slate would win one or two seats out of the five he was seeking, he came away empty-handed. Target announced at the meeting that all incumbent directors were re-elected with at least 70% of the vote.

The mainstream press immediately declared it a rout against Ackman. "Target Triumphs Over Ackman" said BusinessWeek, "Ackman Misses Target" said the New York Post. The New York Times headline read, "Target Shareholders Strongly Reject Dissident Slate."

But the truth is that the vote was far closer than how Target spun it.

The language from Target's press release includes words like "shareholders appear to have" elected the incumbent directors by a "comfortable" margin. Gregg Steinhafel, Target's chairman, president and CEO, goes on to thank shareholders for their "overwhelming" support of management. Towards the end of the press release, Target suggests it will get around to actually releasing "preliminary" voting results in three to four weeks. Final results will come later, but no timeline was provided. Technically, Target doesn't have to share the final results until the end of August -- 60 days after the end of the quarter in which the annual meeting took place.

I find it insulting to shareholders that companies can get away with not releasing voting results immediately after the meeting. A month ago, Bank of America(BAC Quote), a much larger company than Target, with more votes to be counted, and also facing a large number of dissenting shareholders, provided a detailed accounting of its tally before 5 p.m. the same day as the meeting. Target gets to drag its feet for three months, while posturing to the press working on deadline that it enjoyed a sizable win.

Doesn't this sound more like how a banana republic runs itself, rather than one of the largest retailers in the world?

Another aspect of the vote that inflated the results in Target's favor were the broker non-votes. We are now close to the end of the 2009 proxy season. Thanks to some recent changes by the Securities and Exchange Commission this will be the final year in which brokers can take all the non-votes they receive from their underlying shareholder clients and, in one fell swoop, throw the votes to management's favor. This happens in 99% of the cases in which they vote.

The Wall Street Journal recently concluded that, in most large company votes, these broker non-votes going in support of management amount to 15% to 20% of the overall votes counted. These votes should count as abstentions, since the real owners of the shares haven't indicated a preference. Starting in 2010, thanks to the SEC, that will happen.

Let's assume Target received the "overwhelming" support of 70% of their shareholders. Assuming a normal amount of broker non-votes landing on Target's side of the ledger, it appears that the vote, if it had taken place under next year's rules, would have been up for grabs.Scott Galloway, New York University Stern School professor and activist investor with Firebrand Partners, who also serves on the New York Times (NYT Quote) and Eddie Bauer (EBHI Quote) boards, sent a tweet out after the vote saying that it was "a blow to activists everywhere." For the reasons I've outlined, I'm more sanguine. However, I think it's important to understand where things went wrong in this campaign, as I certainly thought Ackman had adequately made his case sufficiently to win at least a couple of seats.

Here's how things went off the rails for Ackman.

1. Winning a proxy contest is like passing a major bill in Congress. It's not enough to be right, an activist has to put forward an argument that is politically palatable to other shareholders. Ackman ultimately failed in his proxy contest because he failed to win over the support of the biggest holders such as the large mutual fund companies and pension funds.

Although these investors pay close attention to corporate governance matters, their primary concern as fiduciaries is the long-term health and success of the company. Activists sometimes shoot themselves in the foot with these shareholders when they advocate solutions that are perceived to provide only a short-term boost to the stock instead of a more sustainable move. Ackman's real estate investment trust plan for Target, designed to unlock value in the land under Target stores, and creative from a financial engineering perspective, got no support. It was successfully painted by Target as "risky" and out of step with the current environment. Ackman never should have included it as part of his plan.

2. The messenger is a big part of the message. Any activist investor in a proxy contest should be able to convince fellow investors that they are advocating solutions which will benefit the company in the long term. Far too many activists formerly looked for short-term levers to pull to create value in their shares owned, such as paying out a large dividend, taking on debt, selling off a division to a private-equity firm, or doing a big stock buyback.

For the most part, these strategies have hurt the target companies. There are also many activists, and Carl Icahn is probably the most well-known example, who have cultivated an image of force and intimidation.

Hedge fund managers -- and activists especially -- are still seen by outsiders as short-termists. In the case of Ackman, he is who he is: a big New York hedge fund manager. He can't change that, but that image likely did bleed away potential supporters who, when they reviewed his REIT plan and heard about the number of Target derivatives he owned, prematurely dismissed his slate for not being a "long-term investor." In the final days before the vote, Ackman went out his way to issue press releases saying he was committed to holding his personal Target shares, not his fund's shares, for at least five years if he was elected to the board. By then, it was too late to change how he was viewed by his fellow shareholders.

3. Pick bulletproof fellow directors for your dissident slate. Ackman didn't help himself with the pick of Jim Donald as a fellow director on his slate. In TV interviews leading up to the vote, Donald didn't provide a compelling list of things he was going to attack once he got elected to the board. It fed into the view that Target wasn't really badly in need of improvement.

Ackman made a big deal of Donald's experience heading up Wal-Mart's (WMT Quote) grocery division, pointing out that Target should emulate Wal-Mart's performance there. Yet Donald also brought the baggage of his bio for being ousted from Starbucks(SBUX Quote) by the guy who hired him. It's not necessarily fair, but this baggage diluted the message Ackman was trying to get across.

4. The worse the stock performance track record of a company is the easier it is for an activist to make the case for change. Joe Nocera of the New York Times took Ackman to task for his Target activist campaign. Nocera questioned why Ackman would go after Target in the first place when the company's 10-year stock performance was actually better than Wal-Mart's. Not every poorly-performing stock makes an attractive activist target, but it's clear that poor performance is a necessary condition for any activist to win over broad support.

Under the SEC's 2010 proxy rules, just as many Target shareholders agreed with Ackman that Target's performance should have been better in recent years as other shareholders who would have sided with Nocera that all this was a waste of time. Yet, as Ackman made constant suggestions that Target should be more like Wal-Mart, it would have helped him more if there was clearly a stark difference between the stock performances of the two companies over some time. It wasn't compelling enough.

I am heartened by how many shareholders last week voted for an activist campaign that, although far from perfect, would have improved on the status quo at a sleepy board. Ackman made mistakes in this campaign that lost him the trust of the long-term holders of the stock. Even still, the final tally likely will show a very close contest.

And next year's new rules from the SEC will mean that investors like Ackman will no longer have to pay $15 million to run proxy contests. Target's vote is more likely to be an early warning of future activist successes than a death knell.

At the time of publication, Jackson owned no shares in the companies mentioned.Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

Disclaimer

The information on Breakout Performance reflects opinions by the authors and nothing contained in this publication should be interpreted as or deemed to be a recommendation to any investor to purchase, sell or hold any security. Any investment decisions must in all cases be made by the reader or by their investment adviser. Nothing contained here is intended as a solicitation.

The views expressed on Breakout Performance are solely those of the author or writers on this site.